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Too quick to cull

Are companies rushing too quickly to push the redundancy button in response to economic turmoil? By Jonathon Hogg, head of people and operations practice, PA Consulting Group, and Mark Thomas, business strategy expert, PA Consulting Group Cutting staff is a traditional response to a recession, but when PA Consulting Group analysed the performance of companies during the 2008 recession the companies that emerged strong and healthy had a carefully judged approach to staff cuts.

The climate of continued economic uncertainty presents companies with a formidable challenge. Do they heed caution and batten down the hatches or do they look beyond the immediate crisis and prepare for future growth? For now, most companies appear to be acting on the instinct that hard and sharp cuts are the right thing to do. A recent survey of 1000 employers by the Chartered Institute of Personnel and Development confirms this. It found that the majority of companies were intending to cut staff rather than hire them. This also appears to be confirmed by a flurry of recent job-cut announcements: 600 jobs to go at Premier Foods, 3100 at Peacocks, 3500 at RBS and 7300 at Astra Zeneca. But are companies rushing too quickly to push the redundancy button?

Cost reduction is the traditional response to a recession, so it’s not surprising that it is the single most common action taken by companies. In a recent survey by PA Consulting Group some 82 per cent of respondents cut costs during the 2008 recession. But when the performance of the companies over the period was analysed an interesting finding emerged. The companies that emerged strong and healthy, as measured by Total Shareholder Return (TSR), appeared to have a carefully judged approach to cost reduction. They did not cut excessively, they tried to preserve staff and they avoided fire sales of businesses at the lowest point of the economic cycle. The PA survey results show the negative correlation between depth of staff cuts and on-going performance.

The message is that companies should think twice about making staff cuts, especially if they reduce capacity in areas where skills take time to build. Cuts in the wrong area or that go too deep could significantly affect a business’s performance down the road. So how to do you get cost reduction right? What is the difference between a ‘good’ approach to cost cutting and a ‘bad’ one?

A bad approach has three characteristics: It is indiscriminate: hard to acquire talent is lost, good businesses are cut just as much as failing businesses; costs are targeted on category of spend rather than whether they are creating value. It damages long-term capacity or competitiveness; technology advantages are dissipated; brand values erode. It restricts the company’s ability to deliver high levels of customer service or product quality.

A good approach, by contrast, focuses on cutting the following: Businesses, products or markets for which growth is either unlikely (for example because the market is in long-term decline) or that are unlikely to create value (because the returns are below the cost of capital). Functions, activities or projects whose outputs are neither essential to the sustainability of the business nor highly valued by customers. Since customer needs are changing, there may be new opportunities to reduce costs here. Cost cutting in moderation may be helpful for performance, but too much of it can be a bad thing. If cost cutting is a company’s only strategy, it’s time to think more creatively and look for other ways to gain competitive advantage. In each sector, only one company can be the lowest-cost provider. If the rest wish to be competitive, they will need to compete on some basis other than cost.

The current economic climate presents plenty of new opportunities to build competitive advantage. A company that keeps its talent and engages its workforce will be better placed to react positively to outmanoeuvre its rivals. These are the companies that will emerge with a sustainably higher market share at the end of this crisis. Another important finding of the PA survey relates to overall mindset: around two-thirds of companies saw the crisis as a time of threat and planned defensively; the rest saw it as a time of opportunity and planned to beat their rivals. The second group had a far higher TSR than the former. One of the key tactics employed by companies that saw the crisis as a time of opportunity was better management. Companies that strengthened their governance as well as acquiring, developing or engaging new talent emerged stronger than their rivals.

The International Monetary Fund, the Organisation for Economic Co-operation and Development and the World Bank are united in predicting heightened risks in the economy, especially in Europe. If and when further turmoil comes, some companies will win and some will lose badly. The winning companies will be those that take steps now to derive advantage by building capability and acquiring talent, whilst all the time looking for opportunities to develop new products and services.

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